Investors seem to expect more economic growth and stronger earnings while shrugging off inflation risks and President Donald Trump's attacks on Federal Reserve independence, Bob Doll suggested in his weekly commentary.
Doll, Crossmark Global Investments' CEO and chief investment officer, sounded a more cautious tone on the longer-term market outlook and said the risk-on environment is already stretched.
"At this juncture, we are suggesting a bear-steepening, given our inflation forecast, i.e., even if short-term rates decline, long-term yields should climb because of higher inflation; eventually, this outcome will put downward pressure on long-duration asset valuations and flip the environment to risk-off," he wrote, referring to a steeper bond yield curve.
Financial markets appear to be factoring in greater odds of better economic growth and corporate earnings while ignoring inflation risks, Doll said.
"Such optimism flies in the face of recent firming inflation data and a significantly positive U.S. output gap. The legacy of decades of first disinflation and then flat inflation means that there is a deeply entrenched belief among investors and the Fed that all roads lead to 2% inflation, without the necessity of a recession. We do not expect such a benign outcome," he wrote.
A risk-on market environment will continue, "since investors are staying focused mostly on the short-term outlook, which is still positive," Doll wrote, noting that strong earnings in recent years have lifted investors and show no stress signals.
This underscores that the downshift in hiring growth has been driven by heightened tariff policy uncertainty and the sharp drop in immigration, not deteriorating profits, Doll wrote.
"Until an economic roadblock develops, investors will remain content to ride the liquidity wave, especially with the promise of more liquidity ahead via lower Fed rates," he said, questioning the advisability of Fed easing.
It appears that investors won't react to the threat of a loss of Fed independence until such an outcome appears imminent, and the potential consequences, like a weaker U.S. dollar, hit home, Doll said.
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